Bernanke talks like a gentle hawk

WASHINGTON (MarketWatch) -- New Federal Reserve chief Ben Bernanke walked a fine line in his testimony Wednesday, establishing his inflation-fighting credentials without scaring the bejeezus out of the market.

In his first congressional testimony, Chairman Bernanke wanted to show his firm commitment to price stability without compromising the central bank's flexibility in coming months to react to unforeseen events. He largely succeeded in testimony that contained few surprises. See full story.

The Federal Open Market Committee expects a robust U.S. economy for the next two years, with inflation likely to bump up against the upper range of its 1.5% to 2% target in 2006 before easing back in 2007. Read the FOMC's report.

That's not a forecast that should send investors heading for the exits.

"The U.S. economy performed impressively in 2005," Bernanke told the House Financial Services Committee in his prepared remarks. "The most recent evidence ... suggests that the economic expansion remains on track." Read his testimony.

Sure, there are risks; there always are. Foremost, there's a danger that the economy will run too hot.

"The economy now appears to be operating at a relatively high level of resource utilization," he said. "The risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately -- in the absence of countervailing monetary-policy action -- to further upward pressure on inflation."

An associated risk is that high energy prices will "pass through into the prices of non-energy goods and services or have a persistent effect on inflation expectations" to a greater extent than now expected.

That's why the policy-setting FOMC has said "some further firming" -- more interest-rate increases -- may be necessary.

The other risk to the economy is that if the housing market collapses, consumers would tighten their belts, boost their savings and cut their consumption.

Bernanke doesn't think that will happen: "A leveling-out or a modest softening of housing activity seems more likely than a sharp contraction."

"The financial health of households appears reasonably good," he said.

With the forecast relatively benign, Bernanke turned to more philosophical matters.

Perhaps to address concerns some have that he would prove to be too soft on inflation, Bernanke presented a textbook defense of the importance of price stability.

Keeping prices stable is not only part of the Fed's legal mandate and good policy in and of itself, it's also "essential for strong and stable growth of output and employment," he said.

Rex
Nutting

Rex Nutting is a columnist and MarketWatch's international commentary editor, based in Washington. Follow him on Twitter @RexNutting.

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